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Funding deal can end threat of the “Barnett Squeeze”

9th December 2016

The UK Government and the Welsh Government are currently discussing the future of a ‘funding floor’ for Wales, designed to protect the relative level of government spending per head in Wales. A new report by researchers from Cardiff University’s Wales Governance Centre and the Institute for Fiscal Studies assesses three options for the floor, and considers how such a floor might interact with the Welsh block grant after taxes are devolved to Wales from April 2018. The report, ‘Barnett Squeezed?: Options for a Funding Floor after Tax Devolution’ is the second report by these researchers on the 2016-17 Fiscal Framework negotiations for Wales.

Even after the devolution of taxes, the vast majority of future Welsh Government budgets will still be funded by block grants from the Treasury, with annual changes to these block grants still determined by the Barnett formula.

A consequence of this formula is that funding per head in Wales can converge towards the level in England, irrespective of relative need – a phenomenon termed the “Barnett Squeeze”.

Over the past decade there have been numerous calls for a mechanism to be introduced which would stop relative funding levels in Wales from falling below an estimate of Wales’ relative need in future.

The extended period of austerity across the UK and Wales’ slower population growth mean that relative funding per head in Wales has actually diverged away from England’s level since the start of the current decade.

By 2015-16, for every £100 per head spent in England on programmes devolved to Wales, the Welsh Government received approximately £120 per head. This is above the Holtham Commission’s estimate of relative need of around £115 per head (see Appendix of press release).

However, convergence in Wales’ relative funding will reoccur automatically when UK government spending begins to once again grow more rapidly.

The report assesses three options of introducing a spending floor to alleviate this “Barnett Squeeze”:

Simple Barnett Floor: The Barnett formula would continue to determine changes in the Welsh block grant, but if Welsh funding per head fell below 115% of the level in England, a top-up would be given to the Welsh Government to make up the difference.

A Fixed Barnett Needs Factor: The annual uplift of additional funds for Wales through the Barnett formula would be multiplied by a fixed needs factor (such as 115%). However, there is no guarantee such an approach would actually lead to spending converging towards the agreed level of relative need (this would depend on relative population growth and expenditure growth).

A Variable Barnett Needs Factor: This approach would introduce a needs factor (regularly updated to reflect relative population and expenditure growth) which would cause Welsh funding to always converge towards an agreed level of relative need.

After tax devolution and the implementation of the funding floor, a key question to consider is which government will bear the future spending and revenue risks associated with different rates of population growth in Wales and England. On the expenditure side, Wales’ relative funding position improves if the Welsh population grows relatively slowly.

Slower population growth would also mean slower growth in tax revenues in Wales, but the method of adjusting the Welsh block grant after tax devolution could insulate the Welsh Government from this population-related risk. For symmetry and accountability purposes, the report suggests this could be done alongside the introduction of a simple Barnett Floor or the Variable Barnett Needs Factor.

Commenting on the report, Ed Poole of the Wales Governance Centre at Cardiff University said:

‘Prolonged austerity and Wales’ relatively slower population growth mean that Wales’ funding per head is now above a needs-based floor identified by the Holtham Commission. But Wales is not out of the Barnett woods yet: relative funding levels will automatically decrease if and when public spending once again begins to grow more rapidly.

“That Wales’ relative funding picture changes so often reflects the fundamental fault of the Barnett formula – the levels of relative spending per head across the countries of the UK it produces are essentially arbitrary and the result of historical accident.”

“The current talks provide the opportunity to acknowledge the higher level of need in Wales and avoid the threat of the Barnett squeeze happening in future.”

David Phillips, Senior Research Economist at the Institute for Fiscal Studies added:

“It’s important that any funding floor sits neatly alongside tax devolution. And, if the basis for a floor is relative need, it’s important that the operation of the floor does in fact lead to convergence in the Welsh Government’s spending power to that needs level – unless of course under- or over-shooting is a result of under- or over-performance in terms of devolved tax revenues,

With this in mind, it looks like combining the so-called “per capita indexed deduction” method for adjusting the block grant after tax devolution, with either a simple or variable Barnett floor could work.

Alternatively, the UK Government could take the opportunity to scrap the arbitrary Barnett formula in its entirety and put in place a more rational funding system that recognises the reality of both devolution and sharing in the Union”.